• Corpus ID: 41906138

Theory of Product Differentiation in the Presence of the Attraction Effect

@inproceedings{Ok2011TheoryOP,
  title={Theory of Product Differentiation in the Presence of the Attraction Effect},
  author={Efe A. Ok and Pietro Ortoleva and Gil Riella and Gustavo Flausino Coelho and Efeito de Atraç{\~a}o and Teoria da decis{\~a}o and David Schmeidler},
  year={2011}
}

• Efe A. Ok, Pietro Ortoleva, +4 authors D. Schmeidler
• Published 2011

We apply the theoretical model of endogenous reference-dependence of Ok, Ortoleva and Riella (2011) to the theory of vertical product differentiation. We analyze the standard problem of a monopolist who offers a menu of alternatives to consumers of different types, but we allow for agents to exhibit a form of endogenous reference dependence like the attraction effect. We show that the presence of such biases might allow the monopolist to overcome some of the incentive compatibility constraints of the standard problem, leading the economy back towards the efficient equilibrium in which the monopolist extracts all the surplus. We then discuss welfare implications, showing that an increase in the fraction of customers who are subject to the attraction effect might not only increase the monopolist’s profits and total welfare, but consumer’s welfare as well. JEL Classification: D11, L12, L15